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Transferring Property to a Child
In many cases, parents are interested in protecting the equity in their home and transferring their property to their children. This transfer of assets to heirs can be accomplished by means of a will, by means of a quit-claim deed and transfer to joint tenancy or may be accomplished by selling the house to your child. When doing this, many homeowners are faced with the inevitable question, can I sell my house to my son for a dollar? In simple terms, the answer is yes, however, since this is not considered an arm's length transaction, the transfer for this small amount could be subjected to gift tax rules.
Investopedia defines an "arm's length transaction" as "A transaction in which the buyers and sellers of a product act independently and have no relationship to each other. The concept of an arm's length transaction is to ensure that both parties in the deal are acting in their own self interest and are not subject to any pressure or duress from the other party."
The homeowner who sells a home to a disinterested third party may lose money on the transaction by selling for a lower price and for the most part the Internal Revenue Service would merely consider this a bad deal. However, when dealing with an immediate family member, the transaction loses any possibility of being considered an arm's length transaction and may be subjected to capital gains tax or to gift taxes (and perhaps both). In effect, it is much the same as money from little or no risk for the child, meaning it could be looked upon as a windfall.
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Capital Gains and Gift Taxes
Because of the laws that govern estate taxes, there is a considerable amount of money that is excluded if you die (in testate) and your child inherits the home. The estate taxes do not come into play unless the amount of the value of the property is in excess of $3.5 million dollars. Most homeowners do not have real estate of this type of value.
For some homeowners (especially those who have multiple homes), one method may be to use the optional gift tax ceilings. This would mean that rather than asking can I sell my house to my son for a dollar, they could transfer ownership to the son over time. This means they would have to be current on the gift-taxing requirements. However, this is another way to transfer ownership to heirs without being concerned about estate taxes or selling the home to the child before they are deceased. The lifetime gift tax cap is currently $1 million and is generally sufficient for most property owners.
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Before a parent attempts to gift a home to their children, there are tax considerations (as well as legal considerations) that should be investigated thoroughly. In many cases, it is beneficial to transfer the property to children prior to death, since they may be taxed at lower rates. A financial planner or a tax attorney can help review individual cases and determine what path is best for each case. It is not a good idea to transfer the ownership of a home to a child for a dollar before finding out the legal and tax ramifications of doing so.
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Sources and Image Credits
- Avvo.com http://www.avvo.com/legal-answers/can-you-sell-your-house-to-a-friend-for-a-dollar-a-186898.html
- Smart Money: http://www.smartmoney.com/personal-finance/estate-planning/passing-your-home-to-heirs-8004/
- IRS: http://www.irs.gov/businesses/small/article/0,,id=164871,00.html